While the FTSE 100 may have risen to a new record high this year, not all shares have performed so well. In fact, National Grid (LSE: NG) has fallen by 15% since the start of the year as investors have shunned defensive utility shares in favour of more cyclical growth opportunities. However, with inflation now standing at 3% and forecast to rise yet further, the company could prove to be a worthwhile buy for the long term.
Defensive income appeal
While the current Bull Run being experienced by the main index could continue over the medium term, inevitably a bear market will come into being. This could mean that it is prudent for investors to hold a mix of defensive shares and cyclical stocks, since the performance of the stock market can change quickly. With National Grid having a defensive business model which lacks high correlation to the performance of the wider economy, it could hold substantial appeal in the long run.
Furthermore, National Grid also has significant income potential. As mentioned, its share price has fallen by 15% this year and this means it now has a dividend yield of 5.1% from a shareholder payout which is covered 1.3 times by profit. This suggests that it could offer a real yield even if inflation continues to move higher. Furthermore, there is scope for dividend growth which is in line with inflation, since there appears to be substantial headroom when the company makes its dividend payments.
Clearly, the utility sector faces a degree of political risk. Domestic energy suppliers could see action regarding price caps. Since National Grid avoids this potential problem due to its focus being on electricity transmission rather than supply, it may offer relatively high share price growth over the medium term.
A stock to avoid?
While National Grid appears to offer a sound mix of defensive and income prospects, gaming retailer Game Digital (LSE: GMD) could be a stock to avoid. It reported full-year results on Wednesday which showed it continues to face an uncertain outlook even though there has been a pickup in demand following the release of various games consoles.
Although trading in the first 15 weeks of the current year has been ahead of group plans, a difficult consumer outlook means that its financial performance could suffer over the medium term. Falling real disposable incomes could cause non-essential items such as games consoles to record lower sales in future, which would hurt the company’s financial performance.
While Game Digital seems to have a sound strategy to reduce costs and maintain market-leading positions in its key markets, it looks set to face trading headwinds. It is forecast to remain a lossmaking entity in the current financial year and this could cause investor sentiment to decline in the coming months. With many retailers offering low valuations and growing profitability over the same time period, there may be superior risk/reward opportunities on offer at the present time.
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Peter Stephens owns shares in National Grid. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.